Blockchain: The Backbone of Finance's Entire Future

People are less excited about bitcoin now--and yet, Blockchain is all over the media these days. JP Morgan Inc (JPM) just announced they are trying out a new blockchain product. Introduced by the first cryptocurrency, bitcoin​, blockchain is the technology that seamlessly runs the digital currency. Although bitcoin is now seven years old, blockchain shot into the spotlight only in the last year or so. Today, it is the buzz word in the financial world, fast gaining prominence outside it as well as within different industries and even governments that are looking to capitalize on this innovative technology. (For related reading, see: The Future of Cryptocurrency.)

Blockchain Basics

So, what exactly is a blockchain? A blockchain is a public ledger of all transactions that have ever been executed. It is constantly growing as ‘completed’ blocks are added to it with a new set of recordings. The blocks are added to the blockchain in a linear, chronological order through cryptography, ensuring that they remain meddle-proof. The blockchain thus stands as a tamper-proof record of all transactions on the network, distributed to all participants.

Thus the validation of any recording on the blockchain isn’t centralized, eliminating the need of a third-party to an intermediate. To put it to better use, these distributed ledgers can be open or permissioned, or restricted or unpermissioned, in terms of the number of people who can access the information. There is an irrevocable trail of all the transactions that have ever been made, which makes attempts of hacking or fraud unsuccessful. Thus, blockchain offers a chance to work at lower costs with greater regulatory compliance, reduced risk and enhanced efficiency. According to a survey report by the World Economic Forum, “10% of global gross domestic product [will be] stored on blockchain technology by 2025.”

According to a Deloitte report, a blockchain is “a technology that allows people who don’t know each other to trust a shared record of events. This shared record, or ledger, is distributed to all participants in a network who use their computers to validate transactions and thus remove the need for a third party to intermediate.”

Blockchain Benefits

Banks have been among the first to look at the benefits of the cost advantages and efficiency that this technology offers them. According to Santander InnoVentures, “distributed ledger technology could reduce banks’ infrastructure costs attributable to cross-border payments, securities trading and regulatory compliance by between $15 – 20 billion per annum by 2022.” It's no wonder banks are “openly and secretly” working in their own innovation labs to explore the technology. In fact, as many as 40 banks from across the globe have joined an R3 CEV consortium working on the distributed ledger technology. On January 20, R3 CEV announced, “the successful completion of a groundbreaking distributed ledger experiment involving 11 of the world’s largest financial institutions.” (For more, see: Blockchain Technology to Revolutionize Traditional Banking.)

Blockchain technology can also help shorten the time involved in trade settlement. The current system involves T+3 days (stocks, corporate bonds, municipal securities and mutual funds shares) while a few require T+2 (foreign exchange settlements) or T+1 (treasury bonds) days. Institutions have been working on methods to condense the time consumed in the process and hence decrease counter-party risk. Blockchain-based smart contracts are being experimented with to provide a solution. Goldman Sachs (GS) has filed a patent application for a “cryptographic currency protocol”-based settlement system for the securities market. Additionally, the technology is being tested to improve transparency and functioning of back-office for securities. Recently, NASDAQ used its Nasdaq Linq blockchain-enabled technology to document the issuance of shares of Chain.com (the inaugural Linq client and its blockchain developer) to a private investor.

Blockchain technology can also be put to great use in the insurance sector, which needs to maintain gigantic records of premiums, claims and payments. The industry faces great threat from fraud, such as “crash for cash.” According to the Insurance Fraud Bureau in the U.K., “Costing around £400m a year, ‘Crash for Cash’ scams are run by fraudsters who manufacture collisions, sometimes with innocent road users, hoping to profit from fraudulent insurance claims. With claims from a single collision potentially worth tens of thousands of pounds, organized fraudsters are orchestrating scams that involve multiple collisions and can be worth millions of pounds.”

Blockchain and Business

The public sector is another area where blockchain has potential use. It can help to make the public sector service more efficient by plugging the loopholes; matters such as citizen identity, vehicle registry, pensions, tax payments, patents and asset (real estate) can be registered on the blockchain. Additionally, industries such as media, diamond, music and healthcare have already started tapping blockchain technology.

According to the World Diamond Council, “An estimated $13 billion worth of rough diamonds are produced per year, of which approximately $8.5 billion are from Africa (approximately 65%). Global diamond jewelry sales continue to grow, increasing three-fold in the past 25 years, and are currently worth in excess of $72 billion every year.” Despite certain mechanisms in place, the industry faces unique problems like insurance fraud and tracking the origin of diamonds; it has struggled to track and check the entry of “blood” diamonds from entering the legitimate supply chain of diamonds. (For more, see: 5 Ways to Invest in the Blockchain Boom.)

Everledger is using blockchain technology as a solution to these problems. Everledger defines themselves as a “fraud detection system, overlaying big data from closed sources like insurers ad law enforcement.” Companies like PeerTracks, Bittunes and Ujo Music have been working to bring the blockchain technology to the music industry. According to a recent announcement PeerTracks has collaborated with MUSE, a blockchain specially tailored for the music industry in association with OpenLedger and Danish bitcoin exchange CCEDK, to resolve the problem of monetizing music in an easy and convenient way.

The Bottom Line

Although the blockchain technology is just making its debut in many spheres of business and industry, there are signs that it is here to stay. This technology, which is the backbone of bitcoin and other virtual currencies, is being endorsed and praised by prominent institutions from the International Monetary Fund (IMF) to government advisory bodies.

A recent report by the U.K. government states, “Distributed ledger technology is already having a profound impact on how private companies manage data and interact with customers and suppliers. If applied within government it could reduce costs, increase transparency, improve citizens’ financial inclusion and promote innovation and economic growth.”